Educational Articles

Stock Screen: Financial Strength Rating Changes - February 19, 2014

Nicholas Patrikis
| February 19, 2014

Value Line assigns Financial Strength ratings across a spectrum from A++ (Highest) to C (Lowest). Generally speaking, the largest companies with the strongest balance sheets get the highest scores. Factors considered in making a rating determination include balance sheet strength, corporate performance, market capitalization, stability of returns, and business outlook, among others.

The Financial Strength rating and a stock’s Price Stability rank are the two main components used to determine Value Line’s proprietary Safety Rank, which measures the total risk of a stock relative to the approximately 1,700 other stocks under Value Line review.

Although a company’s Financial Strength rating is just one factor among many that investors should consider, it is an important one. Moreover, shareholders should take particular note of changes in this rating—both up and down. Value Line subscribers have access to our complete list of Financial Strength upgrades and downgrades each week in the Selection & Opinion section of the product. Noted here, however, are recent upgrades awarded to Facebook (FB) and Priceline.com (PCLN).

Facebook

Although Facebook is relatively new to the public investment scene (IPO on the NASDAQ Global Select Market in May 2012) it is easily one of the most popular and well-known websites on the planet. Founded in 2004 by Mark Zuckerberg, Facebook, Inc. operates the world’s leading social networking service, enabling over a billion people to connect, share, discover, and communicate with each other through its flagship website and mobile application. In fact, at the conclusion of fiscal 2013, FB supported nearly 1.23 billion monthly active users. On top of that, the ever-changing dynamic of Facebook has enhanced its picture and video capabilities with the purchase of highly desirable Instagram, a mobile app and website allowing users to take, customize, and share their captured memories.

Meanwhile, Facebook does not operate in the same manner as traditional companies that sell a specific product or service. Due to the fact that its online service is free for users, the company generates the majority of its revenue through third-party advertising. This poses a challenge to balancing the company’s monetization efforts with maximizing the user-friendly nature of its service. To avoid this pothole, FB looks to inject advertising which holds the most relevancy to its target users’ interests, ultimately improving the experience while simultaneously strengthening the top line. To highlight the company’s recent success, on a year-over-year basis, in 2011, 2012, and 2013, revenues soared nearly 88%, 37%, and 55%, respectively. This equates to a three-year compound annual growth rate of 58.5%, from the 2010 to 2013 time frame.

Indeed, consistent revenue growth can be considered a building block of a strong fundamental foundation, alongside a sustainable business model with bright future prospects, improving profitability, as well as a rock solid balance sheet. All things considered, Facebook’s Financial Strength rating has been recently upgraded from a B+ to a B++, taking into account the company’s standout performance in the aforementioned metrics. Ultimately, risk-averse investors will find comfort in equities that boast above average Safety measures.

Priceline.com

The U.S. based online travel company, which became a public entity in 1999, has evolved into a global network giant helping customers reach desired destinations, sometimes on their own terms. The company offers airline tickets, hotel rooms, car rentals, vacation packages, and cruises, but is most noted for its "Name Your Own Price" service. This allows customers to make offers for travel services at their own discounted "bid" price, which is then be matched up with a database of sellers that meet the required specifications. Indeed, the business model is appealing in the fact that it can accommodate travelers who would otherwise not be able to pay traditional, set in stone prices. Importantly, the company does allow customers to purchase through the normal, price disclosed manner.

Priceline’s bread and butter is its international operations, highlighted by booking.com, which generates the majority of revenues. Rentalcars.com fills the role of car rentals on a worldwide basis. The company also has a foothold in the Asia-Pacific market through Agoda.com. These three operations are managed separately from the Priceline brand, which is only responsible for domestic travel services. However, these companies are all together referred to as the Priceline Group.

In our view, the company is fundamentally sound, which is why it garners one of our Highest ranks for Financial Strength (A+), recently raised from (A). Although the stock’s Price Stability is somewhat uninspiring (50), its score for Growth Persistence is noteworthy (100). This large cap equity (market capitalization of $65 billion) will likely appeal to investors with a low appetite for risk, as its revenue streams are highly diversified and the top line figure is poised to grow at healthy double digit clips, year over year. Furthermore, Priceline is operationally efficient for at least the next few years, boasting operating margins into the low-mid 40% range, based on our forward looking estimates. Lastly, a relatively low debt profile (roughly 20% of its capital structure) augurs well for a persistently strong financial position.

At the time of this article's writing, the author did not have positions in any of the companies mentioned.